Presentation Pro Ch. 4 Demand Before we begin, there’s a couple of important things to recall :

Chapter 4SectionMain Menu 1.What is a “market”?  A market is created when______  Of their own free will, each side willingly ______  Point #1: The interaction b/t buyers and sellers determines the price of most goods and how much will be produced

Chapter 4SectionMain Menu Recalling Adam Smith & the “invisible hand” Goods & services produced in a market economy are the result of Supply and Demand –If people want (demand) a particular good/service, someone will likely supply it to make a profit –So…let’s take a look at DEMAND

Chapter 4SectionMain Menu What is “demand”?? Demand exists ONLY when the following are true: 1. Desire for the item 2. Ability to pay for it 3. Willing to pay for it

Chapter 4SectionMain Menu The Law of Demand As the price of a good increases, quantity demanded decreases Similarly, as the price of a good decreases, quantity demanded increases In other words: when price goes up, we buy less…when price goes down, we buy more Price QD Price

Chapter 4SectionMain Menu Why is this true? 2 separate behaviors overlap: A.the substitution effect and B.the income effect

Chapter 4SectionMain Menu The Substitution Effect occurs when we react to a price increase by consuming less of that good… and more of other goods that satisfy the same basic need The Income Effect The qty of an item you consume changes if its price changes but your income does not

Chapter 4SectionMain Menu Demand Schedules Individual Demand Schedule Price of a slice of pizza Quantity demanded per day Market Demand Schedule Price of a slice of pizza Quantity demanded per day $.50 $1.00 $1.50 $2.00 $2.50 $ $.50 $1.00 $1.50 $2.00 $2.50 $ The Demand Schedule An individual demand schedule is a table that lists the quantity of a good a person will buy at each different price. A market demand schedule is a table that lists the quantity of a good all consumers in a market will buy at each different price.

Chapter 4SectionMain Menu Market Demand Curve Slices of pizza per day Price per slice (in dollars) Demand The Demand Curve A demand curve is a graphical representation of a demand schedule. When reading a demand curve, assume all other factors in the market (income, population, etc.) remain constant. * *important point!

Chapter 4SectionMain Menu Limits of a Demand Curve Can only be used to predict how people’s buying habits might change when price and ONLY price changes To put it another way: A demand curve is accurate for 1 specific set of market conditions

Chapter 4SectionMain Menu Now…it’s your turn: Graphing a market demand curve: Horizontal axis shows quantity w/precise labeling Vertical axis shows price w/precise labeling Label lines, not spaces Be consistent in your “scaling” Provide specific title Write clearly and neatly!

Chapter 4SectionMain Menu Demand for Red Wine (bottles) PriceQty. Demanded $ $ $ $ $ $ $ $ 8.001,000 $ 7.001,400 $ 6.002,000 Label your demand curve D1

Chapter 4SectionMain Menu Sec. 2 Shifts of the Demand Curve Objectives: Sort out the following… (not necessary to write these down!) What is the difference between a “change in quantity demanded” and a “change in demand” ? What factors can cause a “change in demand” ? How does the change in the price of one good affect the demand for a related good?

Chapter 4SectionMain Menu Shifts in Demand Ceteris paribus is a Latin phrase economists use meaning “all other things held constant.” A demand curve is accurate only as long as the ceteris paribus assumption is true. If for some reason qty demanded at EACH and EVERY price changes, the entire demand curve will shift (move) to the left or right When the ceteris paribus assumption is dropped, movement no longer occurs along the demand curve. Rather, the entire demand curve shifts.

Chapter 4SectionMain Menu 1. Income Changes in consumers’ incomes affect demand: “normal good”: a good consumers demand more of when their incomes increase. “inferior good”: good that consumers demand less of when their income increases. 2. Consumer Expectations Whether or not we expect a good to increase or decrease in price in the future greatly affects our demand for that good today. 3. Population Changes in the size of the population also affects the demand for most products. 4. Consumer Tastes and Advertising Advertising plays an important role in “helping us to know what we want” and therefore influences demand What Causes a Shift in Demand? Several factors can lead to a change in demand:

Chapter 4SectionMain Menu The demand curve for one good can be affected by a change in the demand for another good. Prices of Related Goods Complements are two goods that are bought and used together. Example: Substitutes are goods used in place of one another. Example:

Chapter 4SectionMain Menu Major Health Story! It has just been proven that consuming red wine will dramatically speed up the aging process. Studies prove that those who drank 5 glasses of wine per week with their dinner will shorten their lives by as much as 15 years.

Chapter 4SectionMain Menu How will this news affect the demand curve for red wine??? (what will happen to the curve?) Now…construct a new demand curve for red wine using the following figures: (label it D2)

Chapter 4SectionMain Menu Demand for Red Wine (bottles) PriceQty. Demanded $ $ $ $ $ $ $ $ $ $ Label this curve D2

Chapter 4SectionMain Menu Sec. 3 Elasticity of Demand What is “elasticity” of demand? What factors affect elasticity? How does a business use elasticity and total revenue to make decisions?

Chapter 4SectionMain Menu Elasticity of demand measures how much qty. demanded changes when there is a change in price. What Is Elasticity of Demand? Demand for a good that doesn’t change much despite a price change is Inelastic The more demand reacts to a change in price, the more Elastic it is

Chapter 4SectionMain Menu Elasticity of Demand Elasticity is determined using the following formula: Elasticity = % change in quantity demanded % change in price % change = Original number – New number Original number To find the % change in quantity demanded or price, use the following formula: Calculating Elasticity

Chapter 4SectionMain Menu Factors Affecting Elasticity Several different factors can affect the elasticity of demand for a certain good. 1. Availability of Substitutes Few substitutes for a good? demand will not likely decrease as price increases. The opposite is also usually true. (eg heart surgery) 2. Necessities versus Luxuries Which would most likely be more elastic? 3. Relative Importance How much of your budget you spend on the good? (eg: even if pepper doubles in price, you likely do not buy more) 4. Change over Time Demand sometimes becomes more elastic over time because people can eventually find substitutes. (eg: gasoline)

Chapter 4SectionMain Menu The elasticity of demand determines how a change in prices will affect a firm’s total revenue or income. Elasticity and Revenue total revenue: total amount of money the company receives from selling its goods or services. Firms need to be aware of the elasticity of demand for the good or service they are providing. If a good has an elastic demand, raising prices may actually decrease the firm’s total revenue.